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July 20, 2011

If Trading is War, Is All Fair? : In Response

I asked several of our authors and trading experts to weigh in on Monday's post in reference to the New York Times article about high-frequency trading. We received a number of responses with some really enlightening opinions and information from the people that know best. I'm going share some of their expertise here on the blog, so keep an eye our for these upcoming posts.

Program algorithms now comprise more than 70% of all market volume. This transistorized influence has undermined the traditional role of greed and fear in price discovery. In addition, the broad market and individual stocks no longer trend to higher or lower ground according to the classic forces of supply and demand.

Some of these changes are environmental based because there are fewer retail traders in the game in the post-crash era because the wealth effect, generated by the housing bubble, gave the middle class enough capital to open trading accounts and play the markets. High unemployment rates, crashing home values and battered retirement accounts have eliminated these nest eggs, forcing many folks to close their accounts and move on to safer hobbies.

Algorithms take advantage of this thin environment by pushing around prices. They have no human competition in this effort, meaning it’s much easier to break support and resistance levels, without creating pile-on directional momentum. As a result, trading ranges have expanded in recent years, with more whipsaws and fakeouts. The net effort has been magnified by the transition into derivative instruments, i.e. futures, ETFs, options, which now control individual stock movement, like a puppet on a string.

Technical analysis still works well in this brave new world but remaining traders need to apply more defensive strategies at the edges of support and resistance. In addition, classic market principles, like followthrough rallies or selloffs after trend days no longer work well because we’re working in a binary environment in which the market has no memory from session to session.

Comments

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Hi,

I was literally attracted by the post title, yes, there is a huge buzz found in some folks and also some uncertainty regrading the market future vision, but the main essence is that ultra rich markets never get disturbed by the economic slump as investors continue to spend money irrespective of the wider slowdown.